Fantasy Figures
Sun Herald
Sunday February 24, 2002
You can't believe everything you read especially in a modern financial report. Business editor David Potts casts an eye over an accountant's range of magic tricks.
AN AUDITOR working for Rupert Murdoch once told me accountancy was all that stood between the free world and the communist hordes of China. Without the framework of an accounting system, he argued, Chinese companies would always be a risky proposition and there could never be private property.
How the wheel turns.
Wall Street has been savaging companies such as News Corporation because, well, its accounting system has, as the Chinese would say, unique characteristics.
It's not just News Corporation, either. At least there, unlike Enron which collapsed, nobody is suggesting foul play.
Computer giant IBM has been caught soft-shoe shuffling its accounts, attempting, under the benign eye of its accountants and auditors, to treat a one-off asset sale as part of its operating or recurring profits.
Australian companies are no better.
``Australian company history is littered with Enron-type events," says Professor Roger Juchau, an accounting and financial management expert at the University of Western Sydney.
In most cases, if not all, the creative accounting has been perfectly legal.
``When you see a profit figure you know it's arrived at through objective and judgmental data. It's a blend of judgment and fact," says Juchau.
``One would not be surprised if [an Enron-style collapse] happened tomorrow because the regulatory framework is unable to deal with the judgmental element."
David Murray, the head of the Commonwealth Bank, noting that what ``was actually happening in [Enron] deviated from what was reported [in the accounts]", has called for a review of accounting standards and ``related party transactions" bean-counter talk for dealings involving directors or senior management.
Bill Jamieson, author of Balance Sheets The Basics, has no doubt why financial accounts have become so confusing.
``I blame the accounting profession which has allowed them to become too complex," he says. ``They're more worried about standards instead of thecommunity."
Some irony, that the more accountants fuss, the worse the standards become.
This is the middle of the profit reporting season and what you see may not be what you get.
Even blue chips such as Qantas and the banks have critics when it comes to their accounting.
For example, Qantas has been criticised in the past for the way it treats leased planes.
Some of the tricks that corporations get up to would make your hair curl. And there's nothing you or the authorities can do about it.
``Under the current rule set," Juchau warned, ``it's possible to anticipate and defer revenue, defer liabilities, anticipate assets and over or under state.
``There's quite a range of choices open to financial people in companies."
Brokers are the most sceptical of company accounts.
The trouble is they have their own barrows to push, and that can mean turning a blind eye to some corporate faults.
Juchau says he never buys on the recommendation of one broker.
``I crosscheck with two others."
The only regular, independent analysis of financial accounts is done by the Melbourne-based Lincoln Indicators.
It picked the demise of One.Tel in 1999 when it was still a dotcom darling and some two years before its spectacular collapse.
``No-one out there is warning of impending failures," said managing director Tim Lincoln, producer of STOCKdoctor, a software program, regularly updated, which turns company accounts inside out for investors.
More than half of listed companies are in some form of what he calls ``financial distress", meaning chances are that one in two stockbrokers' buy recommendations are for companies that aren't totally sound.
You can't rule out their financial recovery, of course. ``But if they don't they will be One.Tels," Lincoln warns.
Air New Zealand is one company on the critical list. On the other hand Telstra, which has been savaged by the market over the past year or so, isrobust.
``It's a great company. It's the overall market sentiment that's the problem," Lincoln said.
Accountants are the first to throw cold water over published accounts, butthis hasn't stopped them making them more misleading and inaccessible than ever.
Incredibly, the most important information in financial accounts isn't in the main tables, but in the small-print footnotes.
One of the most blatant tricks counting a one-off gain as if it were a regular, year-in-year-out part of thebusiness has now been made even easier.
Another trick is bumping up the so-called intangible assets. These are esoteric items such as brand names, or a newspaper's masthead. Usually some attempt is made to estimate future profit, a feat in itself.
But ``at a workshop a guy from marketing said they are just valuing revenue in an area which could even beunprofitable", according to David Hey-Cunningham, a financial coach and author of Financial Statements Demystified ($45; published by Allen & Unwin).
But the most blatant abusers of the system are, of all people, the banks.
They put the ``restructuring costs" of staff redundancies as an abnormal but when they've been ``restructuring" for a decade or more, the argument wears thin, says Hey-Cunningham.
Abnormals no longer are allowed to be shown separately, but now are ``significant items" buried in thefootnotes.
Goodwill is another grey area.
This is what accountants call the difference between what a company pays for and what a takeover was worth on the books. Cynics might say it measures the amount of overpayment.
Considering surveys have shown that three-quarters of takeovers aren't the roaring success that boards and management claimed they would be at the time, it's no surprise that over the years the goodwill figure shrinks, finishing up as a write-down in theabnormals.
Then there is what has become known as Enronitis.
This is like Alan Bond in reverse. Bond Corporation shareholders might remember how an asset in the company one day would mysteriously vanish the next.
Enron shunted any debts off the balance sheet altogether through a Bond-like structure of subsidiaries that seemed to serve no other purpose thanto deceive. But at least that couldn't happen here, according to Hey-Cunningham.
``Our consolidation rules [putting the parent and subsidiary accounts together] are tougher," he said.
Maybe, but consolidation is still a playground for creative accountants and it's not just little lunch.
Fortunately, there's one dead giveaway, which on its own is probably more valuable than any figure in theaccounts.
``The healthier companies make iteasier to read and understand theirannual reports," Hey-Cunningham said.
``They use clearer English. But unhealthy companies' reports are a lot harder to read and understand."
© 2002 Sun Herald
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